Ch. 18: Demand and Supply in Factor Markets The firm’s choice of the quantities of labor and capital to employ. People’s choices of the quantities of labor and capital to supply. Explain how wages and interest rates are determined in competitive resource markets

Factor Prices and Incomes Factors of production resources used to produce goods and services. 4 factors of production Labor Capital Land Entrepreneurship

Factor Prices and Incomes Factor prices determine incomes: Labor earns wages. Capital earns interest. Land earns rent. Entrepreneurship earns normal profit. Economic profit/loss to owner of the firm.

Factor Prices and Incomes Income earned by the owner of a factor of production equals the equilibrium price times equilibrium quantity.

Factor Prices and Incomes Effect of increases in factor demand: Factor price rises Income rises Increase in price/quantity depends on elasticity of supply Effect of increases in factor supply: Factor price falls Income could rise or fall depending on demand elasticity

Labor Markets Allocate labor and the price of labor is the real wage rate (the wage rate adjusted for the price level). In 2002, labor earned 72 percent of total income in the United States. Source: St. Louis Federal Reserve Bank

Wages by Occupation (May 2007) Hourly wage Annual Earnings All $18.84 $39,190 Management $44.20 $91,930 Legal $41.04 $85,360 Computer and mathematical $33.29 $69,240 Architecture and engineering $31.82 $66,190 Healthcare practitioners and technical $29.82 $62,030 Education, training, and library $21.79 $45,320 Construction and extraction $18.89 $39,290 Installation, maintenance, and repair $18.78 $39,060 Protective service $17.81 $37,040 Sales and related $16.52 $34,350 Office and administrative support $14.60 $30,370 Transportation and material moving $14.16 $29,460 Healthcare support $11.83 $24,610 Personal care and service $11.02 $22,920 Building, grounds cleaning, &maintenance $10.86 $22,580 Food preparation and serving related $8.86 $18,430 Source: Bureau of Labor Statistics

Source: Forbes Magazine, 2008. Most Lucrative College Majors

Source: Forbes Magazine, 2008. Most Lucrative College Majors

The Demand for Labor A firm’s demand for labor is a derived demand derived from the demand for the goods or services produce by the factor. The marginal revenue product of labor (MRPL) change in total revenue that results from employing one more unit of labor. MRPL = MPL  MR = MPL X P if perfect competition

Labor Demand Curve 1 5 2 9 3 12 4 14 15 L (no. of workers) TP MP TR if P=MR=4 MRP if P=MR=4 1 5 2 9 3 12 4 14 15

Labor Demand Curve MRP falls as L increases because of law of diminishing marginal returns. Firm should hire more labor if MRPL > W and stop when MRPL =W How many workers should firm hire if Wage = $8 Wage = $12

Labor Demand Curve The marginal revenue product curve for labor is the demand curve for labor. “consumer’s surplus” in labor market = increase in profits from hiring labor.

Labor Demand Curve The demand for labor (MRPL ) rises and the demand for labor curve shifts if: The price of the firm’s output rises (MR rises) Worker productivity rises (MP rises) The prices of other factors of production change Substitution effects Scale effects Technology changes (could increase or decrease demand for labor)

Labor Demand Curve Market Demand The market demand for labor is obtained by summing the quantities of labor demanded by all firms at each wage rate. Because each firm’s demand for labor curve slopes downward, so does the market demand curve.

Labor Demand Curve Elasticity of Demand for Labor The labor intensity of the production process The elasticity of demand for the product The substitutability of capital for labor Importance of elasticity of labor demand Minimum wage effects Power of unions Effects of immigration on wages